So, Who's Really Afraid of Amazon.com Taking Over the Entire World? I'm Not!
Amazon: Be Careful What You Wish For
May 21, 2020 12:14 PM ET
Summary
Amazon.com is one of a handful of tech behemoths with market caps exceeding $1 trillion. However, unlike other companies with similar valuations, Amazon doesn't generate much free cash flow and doesn't return any cash to shareholders.
Investing in Amazon is a bet that its retail business will achieve unprecedented sales volumes and high margins a decade or so from now.
Amazon bulls may be underestimating the risk that the type of success they envision would actually be self-defeating by inviting antitrust enforcement action.
Over the past decade, Amazon.com has gone from being the leading player in a relatively small (but growing) e-commerce market to a retail behemoth far outstripping every competitor except perhaps Walmart.
Whereas investors once debated how large Amazon could grow or whether it could ever be consistently profitable, most now seem to assume that the company will dominate retail in an unprecedented fashion. They also expect it to be one of the leading tech companies in the world (through its AWS subsidiary), and that both divisions will generate massive profits for decades to come.
One certainly can't argue with Amazon's revenue growth. Sales grew from less than $25 billion in 2009 to over $280 billion last year. Meanwhile, Amazon stock has appreciated about twice as fast as the company has grown its revenue over the past decade. However, Amazon still doesn't generate much in the way of earnings or cash flow relative to its market cap, which now exceeds $1.2 trillion. (It trails only Microsoft and Apple, which both generate far more cash and return lots of it to shareholders). This implies that investors expect breathtaking earnings and cash flow growth for many years to come. Yet it isn't clear how Amazon can deliver the growth it would need to justify its towering valuation.
Massive scale, but still not much profit
Up until two years ago, Amazon was barely profitable. In 2017, the e-commerce giant generated just $4.1 billion of operating income and $3 billion of net income. Profitability has improved considerably since then. Operating income surged to $12.4 billion in 2018 and improved further to $14.5 billion in 2019. Net income reached a record $11.6 billion ($23.01 per share) last year.
Still, Amazon is hardly knocking it out of the park with respect to profitability. Its mid single-digit operating margins for the past two years are similar to Walmart's historical performance. If anything, its margins will deteriorate this year due to costs related to COVID-19 outstripping the benefit of people turning to e-commerce over brick-and-mortar retail. Bulls often tout free cash flow as a more important metric of Amazon's performance than operating income or net income. Amazon reported free cash flow of $25.8 billion for 2019: more than double its net income. However, that figure is rather misleading.
First, Amazon's extensive use of finance leases (especially at Amazon Web Services) distorts its free cash flow. Recognizing this, Amazon reports two alternative free cash flow metrics in its financial statements. One of those ("free cash flow less principal repayments of finance leases and financing obligations") adjusts free cash flow (see p. 29) by deducting (approximately) "the actual payments of cash for our finance leases and financing obligations." As such, it arguably captures the movement of cash in and out of the business more effectively than the traditional free cash flow metric.
Last year, Amazon made nearly $10 billion of principal repayments for finance leases and financing obligations. As a result, free cash flow less principal repayments of finance leases and financing obligations totaled $16.2 billion in 2019: up from $11.6 billion a year earlier but well below reported free cash flow.
Second, stock-based compensation (in the form of restricted stock units) makes up a significant portion of employee pay at Amazon. Since Amazon hasn't bought back stock in a long time, the company's generous stock-based compensation means that shareholders are getting diluted gradually, year after year. During 2019, Amazon's diluted share count rose by about 5 million shares. This level of dilution has been pretty typical in recent years. Based on Amazon's recent share price, the company is issuing over $12 billion of stock a year to employees, in lieu of cash compensation.
The value of the stock being issued each year offsets the vast majority of Amazon's free cash flow, after adjusting for finance leases. Indeed, a cynic might say that Amazon's main business in recent years (or at least its main source of cash flow) has been the issuance of its own shares at ever-increasing prices.
Competition or antitrust problems?
Amazon.com stock has soared to new all-time highs in 2020. Enthusiasm about AWS may account for some of this rally, but even at a generous multiple of 12 times sales (above average for cloud-computing companies), AWS would be worth less than $500 billion. That would still attribute the bulk of Amazon's value to its retail and marketplace business.
Thus, a better explanation for Amazon's soaring valuation may be that investors expect the e-commerce giant to make massive market share gains as the fallout from COVID-19 causes many weaker retailers to fold. In theory, that could pave the way for both a dramatic increase in Amazon's sales base over the next several years and a big improvement in the profitability of its retail operations.
It's certainly true that many retailers are likely to fail in the near future. But for the most part, the retailers that disappear will be those that have been struggling for a long time and have already ceded a lot of sales to rivals (including Amazon). Amazon's biggest competitors, such as Walmart, Target, Costco, Kroger, and TJX Companies aren't going anywhere. Thus, it's not clear that COVID-19 will actually have a material impact on the long-term competitive environment. (Indeed, most of the retailers that will go out of business may have been doomed anyway.)
If COVID-19 does result in greater market share gains and higher pricing power for Amazon, that could lead to a different set of issues. There are already growing calls from both the left and the right to increase regulation of (or even to break up) big tech companies including Amazon.
Of course, this doesn't guarantee that Amazon will run into antitrust issues. However, the more successful it becomes, the greater the risk. The kind of performance that would justify a $700 billion-$800 billion valuation for Amazon's retail business today (e.g. growing retail revenue to over $1 trillion and gross merchandise volume to around $2 trillion over the next decade while expanding its retail operating margin to 10% or more) would dramatically increase the likelihood of Amazon being targeted by antitrust authorities.
Perhaps it will be possible for Amazon to deliver enough earnings and cash flow growth to justify its valuation without triggering antitrust enforcement that would permanently diminish its value. But over the long run, it will be extremely difficult to thread that needle.
A dynamic growth story, but what's the destination?
From a short-term perspective, it's obvious why investors love Amazon. Despite the company's massive size, it continues to grow revenue by about 20% annually. It is already the top dog in cloud computing and is on the road to dominance in the retail industry, too (at least in North America). Moreover, its margins have improved significantly over the past two years or so.
However, Amazon is unique among trillion-dollar companies in not returning any cash to shareholders. After adjusting for its liberal use of finance leases and stock-based compensation in lieu of cash salaries and bonuses, it still generates barely any free cash flow. In addition to paying zero dividends, Amazon's share count rises year after year.
This means that expectations for spectacular long-term earnings and cash flow growth underpin Amazon's valuation. Yet the greater the company's expected future profitability, the higher the risk that Amazon will run into regulatory issues due to potential antitrust violations. That makes buying Amazon stock at its record high near $2,500 a dubious proposition. The company's valuation implies a near certainty that it will grow to over $1 trillion in revenue and annual free cash flow exceeding $100 billion within a decade or less. Investors don't seem to be considering that the future state of the world they envision might not be possible. Even if Amazon were to grow its revenue and margins as bulls expect, becoming extremely big and extremely profitable could be self-defeating if it leads to an antitrust crackdown. Or, to use the words of Gertrude Stein, maybe "there is no there there."
Amazon.com: The Mighty Paper Tiger!
By Mark Oglesby a former Amazon.com Warehouse Worker, Union Organizer, Worker’s Rights and Safety Advocate.
In an article by Reuters concerning comments made by U.S. Treasury Secretary Steven Mnuchin, an overall statement was declared, out of pure ignorance I maintain, that the online giant Amazon.com Inc had “destroyed the retail industry across the United States.”
Mnuchin went on to speculate: “If you look at Amazon, although they’re certain benefits to it, they’ve destroyed the retail industry across the United States,” Mnuchin told CNBC. “I don’t have an opinion other than I think it’s absolutely right the attorney general is looking into these issues and I look forward to listening to his recommendations to the president.”
In their own defense, the Amazon PR Amdroids (APRA) stated that 90% of all sales occur in brick-and-mortar stores. “Today, independent sellers make up more than 58% of physical gross merchandise sales on Amazon, and their sales have grown twice as fast as our own, totaling $160 billion in 2018,” an Amazonian Ambot (AA) alleged. Now as much as I hate to agree with whatever spews forth from the Amazonian Propaganda Machine (APM), I am forced to acknowledge that the once again Amazon PR Amdroids (APRA) were spot on the mark. Speaking of which, the subject of this opinion piece or general thesis concerning Amazon.com remains this: Amazon.com: The Mighty Paper Tiger!
First question then: What actually does it mean to be a Paper Tiger? From WikipediA: “Paper tiger” is a literal English translation of the Chinese phrase “zhilaohu” (纸老虎／紙老虎). The term refers to something or someone that claims or appears to be powerful and/or threatening but is actually ineffectual and unable to withstand challenge.
Now this being the case concerning Amazon.com; the issue refuses to go away: How can anyone in their right mind consider Amazon.com to be a global powerhouse? A legitimate question which I will now answer!
What does Amazon.com actually own? That is, what assesses do they possess? Not much beyond their inflated stock price I’m afraid! Basically speaking, the company leases practically everything in their “mighty” industrial arsenal. And all of these leases are now (since December of 2018) considered debts which must exist on their accounting books as outstanding balances which have no value since someone else actually owns them. Think of being a renter who has no equity in the house, condo or apartment in which you dwell but have to list the above stated house, condo or apartment as debt against your income-to-debt ratio while once again having no viable asset to counter-balance the negative division of what does not belongs to you; that which belongs to someone else.
And speaking of debt, Amazon.com’s leveraged up to its preverbal eyeballs wherein free cash flow is practically speaking: non-existent! As an example, looking back to all those leases; Investopedia has this to say: A leveraged lease is a lease agreement that is financed through the lessor, usually with help from a third-party financial institution. In a leveraged lease, an asset is rented with borrowed funds. The online retail giant’s drowning in debt! The ship’s falling into the sunset! The Canadian Government Marine Agency here at 4.15 P. M. received a wireless dispatch that the Titanic is sinking.
Now all things being equal and everything considered concerning Mnuchin’s statement of destroyed the retail industry across the United States, the fact of the matter remains (and this’ something the government and corporate business leadership not to mention the US Chamber of Commerce will not speak about): The American working population has no disposable income to spend! That as productivity continues to rise, wages have flat-lined or moved up only slightly! Debt ridden workers have been maxed out as only living expenses can be considered when it comes to everyday shopping!
And consider this! Stop and ask a store owner in the local shopping mall what his or her rent is and how much it has continually grown over the years? As a matter of fact, it’s enormous as store after store closes due to the high cost of rent! Amazon’s fault? Hardly! Plus, drive from city to city anywhere in the United States of America and count the number of malls in existence here in the land of consumer capitalism: We’re awash in our consumer culture; drowning in debt while chasing the American dream!
To conclude! I am no friend of Amazon.com as I fight their brutality toward their employees with passion and determination: I will never give up! But the question still remains: Is Amazon.com really bringing down brick and mortar buying and selling or as Mnuchin maintains: …they’ve destroyed the retail industry across the United States? Hell no! They haven’t the capacity to take care of their own house let alone bring down entire industries!
YES! TheAmazon has killed small businesses worldwide (how many independent book stores do you know of that exist in the city in which you dwell?) as bullies always pick on smaller children in the playground. But when this “Paper Tiger” goes up against companies which possess muscle such as Amazon.com claims to enjoy having itself; well, ask this: How many Whole Foods stores have you run across since Amazon bought (on credit by the way) out the company? Barely a glitch on the radar screen! This then is the “Paper Tiger” of which I speak!